How serious are the problems of late payments and defaults for small and mid-size businesses (SMBs)? Half of all net-30 invoices owed to SMBs are paid late, according to a 2015 study by Fundbox, an online funding platform.
Cash flow problems like these can starve a business to death. According to a U.S. Bank study, roughly 82% of small businesses actually fail due to inefficient management of cash flow. And while larger organizations may be better equipped to absorb a loss, non-payments can erode profits, ruin growth plans, and even shutter a small business.
Of course, most businesses try to evaluate and track the creditworthiness of their customers, but that can be difficult and time consuming. Solving the challenge is critical. Companies need to make certain that their customer credit management practices are optimized. Here are 10 keys to strengthening the process.
1. Research your customers before signing contracts. It’s important to learn as much as possible about the company you’re going to do business with and to start the research process as soon as you begin talking. Use various information sources, not just credit bureaus. Also try the local chamber of commerce, bank and trade references, and the company’s 10-K. Even existing customers should undergo periodic reviews.
2. Clearly document terms and conditions. State in writing all delivery and payment conditions, and discuss any provisions in the agreement. This is where you can indicate whether certain conditions apply, and that you do not accept any other conditions. To start, check with your trade association for the conditions typically used in your industry. Before entering into the contract, ask a lawyer to review the conditions.
3. Make sure customers sign receipts. Verify that the person who signs each receipt for your products or services has the proper authority. Also ask for a company stamp on each receipt.
4. Bill quickly after delivery. All key data should appear on your invoice so that it doesn’t hold up payment. The basics include:
- Your company name, address and telephone number, along with a contact name
- Your customer’s proper company name and address, and the right contact person
- The nature and quantity of the goods or services
- The price in the appropriate currency
- The agreed-upon payment period
- Your bank account number
- Your terms on the back of the invoice
- Supporting purchase orders, if applicable
5. Call customers on or before payment due dates. If you have not received payment, call customers just before or on the invoice due date. Calls can be made by the accounting department or sales, depending on the relationship with each customer. This call confirms the products you delivered and that your invoice has been received. This step also provides good customer service. It helps prevent late payments if your customer is not satisfied with the delivery while there’s still time to rectify the issue. Consider offering your customer a small discount if they pay on time.
6. Create a payment reminder process. If a customer does not pay on time, call and follow up with a written reminder that you are expecting payment within a reasonable time, such as one week. If the customer still doesn’t pay, send a warning and, eventually, a formal written notice. This typically asks for payment within two business days and presents a specific date by which the money must be received before legal proceedings start.
7. Use written late-payment agreements. It’s reasonable to expect that some customers may simply need extra time to pay. For them, create a written late-payment schedule. You should also monitor the customer’s progress to make certain they comply with the agreement and are not on the verge of bankruptcy. Also inform your credit rating agency because late payments by your customer may have implications on your own creditworthiness. Make sure to note all terms of the agreement, as well as:
- The total amount due
- The payment periods
- The specific dates when payments must be received
- Your bank account number and other routing information if payments will be wired/transferred electronically
- Supporting documentation, including purchase orders, if applicable
8. Document and communicate your process to your company. Communicate your credit management process to other departments. This ensures tasks and responsibilities of staff in other departments are clear to everyone; they may be able to play key roles collecting invoice payments. Also hold staff accountable, and periodically evaluate how well your credit management process meets the needs of the organization.
9. Periodically review new financial information without bias. Most companies review a customer once and then assume nothing changes. Be sure to review each customer with a frequency that aligns with the perceived risk they present and their potential for default. Be careful to avoid any biases caused by personal relationships. Just because you have a good relationship with a customer doesn’t mean they won’t default.
10. Set ambitious actions and goals. It’s easy to underestimate the value of effective credit management. But done well, it helps mitigate unnecessary risk, creates opportunities for improvement, and frees working capital for business investment. So set actions and goals, measure your performance, and apply changes when necessary. A few examples of objectives include:
- Identify the average days sales outstanding (DSO) in your industry (average number of days invoices go unpaid).
- Lower your DSO within a given period. Your industry average will help you determine a sensible benchmark.
- Reduce the number of bad debts and annual
- Compare your results with those of industry
- Maintain a healthy diversification of buyer portfolio
As you put these practices into action, remember that credit management is not a one-off project. It’s a continuous process. With success, you can accelerate invoice payments and help optimize your organization’s working capital. Effective credit management generates cash flow your company can invest in the future and proves the value of the process to the entire organization. Yet even the most prudent strategy can’t eliminate all risk. Tools like credit insurance provide a deeper level of information about the health of your buyers and can protect you in case of an unexpected loss.
James Daly is the CEO at Euler Hermes Americas, a leading provider of trade credit insurance.